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How To Commit Fraud As Owner Of A Bitcoin Exchange

Of course there have been people who have owned Bitcoin-focused websites who have simply stolen the bitcoins of the users of their website, often saying, “I'm sorry but some bad person has hacked into the website and stolen everybody's bitcoins, so now I'm closing the website down,” but fraud is always better if you can do it without the fraud being clearly identifiable as a fraud. You can then carry on with your life, admittedly with a tarnished reputation but without fear of legal action and possible wealth-seizure and imprisonment. (You might nonetheless, however, be at risk of a beating up or even a bullet in the head.)

If any of you own, for example, a Bitcoin exchange - exchanging bitcoins for 'real', fiat money, and vice versa - here is a way that you could defraud people of their bitcoins and their dollars, etc., and probably get away with it.

The first thing you must always bear in mind, as far as money is concerned, is that you want it coming your way, and as much as possible you must resist giving money to other people (even if it is their own money that they're wanting from you).

So let's say you're attracting other people's real money (dollars, etc.) and pretend money (bitcoins and other cryptocurrencies) by operating an exchange that lets them trade one for the other. After a time your exchange is full of (let's say) dollars and bitcoins. The problem is, these dollars and bitcoins technically belong to other people. All you've done is earn pennies here and there in the tiny commission you charge every time someone does a trade or withdraws dollars or bitcoins from your exchange.

The question is, how can you get these other people's dollars and bitcoins to become yours, and how can you do it in such a way that it appears that you haven't done anything illegal? (You should be prepared to look incompetent and inept, but if you handle this right, you will be able to make it look as though you have just been very cautious and punctilious in protecting other people's financial security.)

The first thing to do is to make your bitcoin-dollar exchange a one-way street. In other words, you continue to allow people to deposit dollars and bitcoins into your exchange, but you stop them from withdrawing dollars and bitcoins. You will have built up to this by gradually extending, over the previous months, the length of time that it takes for people to be able to withdraw dollars and bitcoins from the exchange. For example, you will have let it become public knowledge that it takes weeks, not days, for any dollar withdrawals to be completed, and it takes hours, not minutes, for bitcoin withdrawals to be completed. This way it doesn't come as such a big shock when you announce that dollar withdrawals will suffer additional delays (in other words, you won't bother processing them at all) because of the heavy volume of withdrawal requests, and you announce that bitcoin withdrawals will stop altogether.

But if you've got away with not processing people's dollar withdrawal requests (although it will take months for your mug clients to realize this for certain), how can you legitimately prevent your nasty, greedy, selfish clients from taking their bitcoins out of your grasp?

Obviously you tell them that it's for their benefit and it has been done entirely in their interests.

What you do is say that there is a fault with the Bitcoin protocol that means bad people are able to cheat individuals, and your exchange, out of bitcoins. Nobody wants to see that happen, so while you are dealing with this problem, as a safety measure you have stopped bitcoin withdrawals.

But what can you say is wrong with the Bitcoin protocol that would justify preventing your exchange's clients from getting at their own bitcoins?

Use your imagination! Invent something.

I would invent 'bitcoin plasticity'. This would be a bitcoin affliction that allows a bad person to bend a bitcoin transaction on its way to a particular bitcoin wallet so that it instead curves over the internet and ends up in the bad person's bitcoin wallet.

This bitcoin plasticity would obviously mean that people might not end up getting their bitcoins if they withdrew them from your bitcoin exchange, so in order to prevent people from being at risk of such a loss, you simply stop them from being able to withdraw their bitcoins from your exchange.

You see, you have done this to protect your clients and to prevent them from losing any of their bitcoins. This is very noble and generous of you. You are a beacon of saintly light in a dark and evil world.

However, strangely enough you allow yourself to withdraw bitcoins - anybody's bitcoins - from your exchange. This is because you are brave and fearless, and dare to tread where you will not allow others to tread.

At the moment you are not breaking the law (not that laws really enter into the Bitcoin realm, other than when the US government decides it does). But now that you have 'de facto' control of the bitcoins and dollars in your exchange, how can you get all, or at least most or many, of them in your own personal possession?

With your exchange closed to bitcoin withdrawals (but still open for fools and optimists to deposit bitcoins and dollars with you), but with dollar withdrawals supposedly still possible (but actually … not!), your exchange's clients will see that the only hope they have of getting anything out of your exchange is to sell their bitcoins for dollars and then to request that you send them their dollars. So everyone starts selling bitcoins for dollars, and the bitcoin price plummets.

This is where you make your killing. There are two ways of doing this. One is completely legal. The other is legal 'after the event'.

The first way is to use your own dollars, in your own account, at your own exchange, to buy the cut-price bitcoins that are being offered for sale by your exchange's desperate clients. Having bought these cheap bitcoins, you then withdraw them from your fraudulent exchange to an honest one, where the bitcoin price is still at what might be called a 'normal' level. You sell the bitcoins for dollars, transfer the dollars to your bank account, and then transfer the dollars back into your account at your own exchange.

Repeat for as long as you wish or as long as you can.

The second approach, which involves you stumping up no 'real money' of your own, and therefore gives you entirely positive cash flow, but which is riskier, and has the potential to end in disaster, or at least involve you in making hurried external purchases of bitcoins to make sure everyone's accounts at your exchange hold the bitcoins that they should hold, is to do the following. Simply take bitcoins from people's accounts at your exchange (fiddle with the software so that your 'borrowing ' doesn't show up) and then transfer these bitcoins to your account at an honest exchange, sell them for dollars at the 'normal' exchange rate, transfer the dollars to your bank account, then transfer the dollars to your personal account at your own exchange. Now use these dollars to buy cut-price bitcoins from those of your exchange's clients who still have them, then 'gift', i.e. transfer, these cheaply bought bitcoins back into the accounts from which you initially 'borrowed' the bitcoins to sell at the normal rate on an honest exchange. The dollars left in your own account at your exchange represent the profitable difference between what you sold your clients' bitcoins for on the honest exchange, and what you bought them back for from other clients of your exchange who still held bitcoins.

You can see that the danger with the second approach is that you 'borrow' so many bitcoins to sell on another exchange that you don't leave enough bitcoins in clients' accounts in your own exchange to be able to buy to replace the bitcoins you 'borrowed'. Also it might happen that when you want to buy cheap bitcoins to replace the one's that you've 'borrowed', withdrawn and sold at normal price, the remaining bitcoin-holding clients at your exchange simply don't want to sell. In that case, if you don't want to be done for straightforward theft (if bitcoin theft could be proved in a court of law), you will have to go to an honest exchange and buy in some bitcoins at 'normal' market price to put back in the accounts at your exchange from which you 'borrowed' bitcoins. That, of course, removes some, or all, of your profit, and defeats the object of the whole exercise.

The first approach is therefore the safest approach and is, as mentioned, completely legal.

Because the money transfers from the honest exchange to your bank account and from your bank account to your personal account at your own exchange will take several days, it means that for you to be able to run through several profitable cycles of this fraud, you will almost certainly need to keep your exchange closed for several weeks.

The question is, once you've made as much money as you want or you can, what do you then do with your exchange?

You can do one of two things. The first is probably the most sensible because after this escapade your exchange's reputation will be in tatters, as will your reputation. What you do is announce that your exchange is ceasing trading, and that everyone should - indeed must - withdraw all the bitcoins and dollars that they hold in their accounts at your exchange.

You then quite honestly pay everyone the bitcoins and dollars that they hold with you. You then close the exchange. All the dollars you have made should now be sitting safely in your personal bank account, and you are comfortably set up for life.

The second approach, which really seems rather silly in the circumstances because after this episode no one will want to use your exchange anyway, is simply to reopen it to normal trade, allowing people to withdraw their bitcoins as and when they wish. You go back to allowing dollar withdrawals with the same old lethargy and tardiness with which you allowed them to take place in the past.

The possible advantage with the second approach is that gradually, as people's memories fade, your exchange might build up a good client base again, and have a substantial holding of bitcoins and dollars again, and then you will be able to repeat the fraud once more.

So there you have it! Fraud … but to all intents and purposes, legal.


Bitcoin | Cryptocurrency


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